The Florida Cabinet made the right decision by authorizing the Florida Hurricane Catastrophe Fund (Cat Fund, a government entity) to buy $1 billion of reinsurance as part of its $17 billion in claims-paying resources. The $1 billion of reinsurance was bought at modest cost and it will spread the cost of any calamity beyond Florida’s borders. Buying reinsurance is tightly focused in that the money is spent on pure protection, unlike when Cat Fund issues pre-event bonds to raise cash. Cash is much more fungible, and tempting to divert to other uses.
Cat Fund offers reinsurance to a lower-tier of Florida insurance companies, including Citizen’s Insurance, a government-run provider of casualty insurance. At one time Citizens had 1.5 million customers, but it shed many customers and now insures only 600,000 customers. For protection during years when losses exceed Citizens ability to pay, Citizens buys reinsurance from Cat Fund. The amount of reinsurance Citizens needs depends on the weather and the adequacy of Citizens insurance premiums.
Citizens’ first order of business is to set premiums at a level that will cover the average losses anticipated. Setting insurance premiums too high is unfair to Citizens’ own consumers but setting premiums too low is unfair to all casualty insurance consumers.
In the past, when Citizens premiums were too low to cover losses within a few years, a special assessment was levied on all casualty insurance companies, whether or not they were a Cat Fund customer. In effect, Cat Fund made up the shortfall in Citizens premiums by taxing insurers who covered the 1.5 million households not insured by Citizens Insurance. That Cat Fund assessment was in effect for about 7 years.
Actuaries can use weather history, inflation and property records to estimate the financial risks from storms. The average risk includes damage from the usual handful of mild storms in most hurricane seasons plus a proportional share of devastation from “once in a decade” and “once in a century” storms. The average risk may not be experienced in any specific year, but over periods such as a decade, the total of estimated risks should be near to the actual losses. Citizens’ job is to manage the yearly financial misfit between premiums and losses.
In a year when the amount of premiums, less administrative costs, is more than that year’s loss payouts, Citizens will have funds left over. Left-over funds could be used to decrease future premiums, a popular political ploy. A far smarter tactic would be to accumulate those funds and use them for above-normal losses in upcoming years.
In any year when the amount of premiums, less administrative costs, is less than the payouts required, Citizens would pay current losses from a mix of premiums, reinsurance coverage, and the accumulated left-over funds from prior years of low-losses. Floridians’ deep dislike for special insurance assessments should prevent their recurrence.
The Florida Cabinet’s approval of reinsurance moves in the right direction. Reinsurance helps align costs and cost causation by shepherding Cat Fund and Citizens into a regimen of “pay as you go” rather than the ill-disciplined habits of preemptively borrowing and retroactively using special levies.
Alan Daley lives in Florida and writes for The American Consumer Institute Center for Citizen Research